LET US CONSIDER two different ways in which you may work for a company. The relevant difference is whether you are an entrepreneur who decides to incorporate your business undertaking, or just an outright employee of a company.
In fact, the range of ownership of a business can vary across a continuum from a company with a sole shareholder and owner, to a company with many shareholders and professional management appointed by a board of directors. The risks related to earning from this range of company ownership vary just as widely.
As an owner or even part owner of a company, an employee will find that his drive and motivation may be different than when he is just an employee with little or no ownership interest.
First, as an owner, no matter how relatively small the investment, an employee can earn in three ways – one is through the payment of salary and benefits for services rendered either as an employee or contractor of the company, another is by the payment of dividend on his investment, and finally if the business prospers and grows by the increased value of the share in the business owned.
If the business is doing well and making profits, there will normally be an increase in equity through retained earnings. The shareholders in the company share any such increase in proportion to their shareholdings. This increase is called the capital growth in the company and to the extent that such profits are not distributed as dividends, an employee who is a shareholder also earns through unrealised capital gains. Such earnings are non-cash earnings.
Unfortunately, if the business is making a loss, the converse is true. There is an erosion of equity per shareholder also in proportion to shareholding. Thus, any earnings from capital gains will only remain earnings if the company continues to make profits or at least breaks even. Any future operating losses by the company will dissipate accumulated capital gains.
The entrepreneur who decides to operate his incorporated business often tends to find that he is the only shareholder when he first sets up. It is quite difficult to convince others to invest without a proven track record.
For such a sole shareholder company, the risks to earnings are high. Yet the likely return can be very high if the business should bloom. The company is a separate legal individual. The owner can draw payments (earnings) from the company by way of salary and dividend.
However, the company has to be run in such a way that adequate cash flow exists to make payment. If payment cannot be made for whatever reason, this employee can only complain to himself as business owner.
The plight of another person working with this company is only slightly better in that they can complain to the owner and sue the company. Yet if the company goes bankrupt and truly cannot pay, that employee will have to seek government assistance as well as start looking for another position.
Where a company is bigger in terms of having a number of shareholders, some of these risks may be reduced. There is more likely to be greater depth in the management of the company and so a better chance of business success. An employee of such a company would therefore tend to face lower risks of loss of earnings.
A successful and diversified company also tends to provide employees with more sophisticated pay packages that reduce other risks of the employee’s life. Yet even the biggest of companies can fail. Size is not a fail-proof feature.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances.
This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.
